Since this is a legal compulsion it is tempting for owner-directors to view the annual audit as simply an imposed cost. However, Gavin Young, director of audit and assurance at accountants Johnston Carmichael, points out that there are two fronts on which the audit firm can generate real value for money for small to medium-sized enterprises (SMEs).
"Value for money comes from what we can do for the client and what the audit does for the people who are going to be looking at the company's accounts, of which the bank and external funders are probably the most important from the company's perspective," he says.
He points out that banks have naturally become much more interested in exploring the detail in company accounts in the current weak economic environment. When the bank knows that an audit firm will be coming in once a year with a clear head and a clean sheet of paper to examine the company's accounts, that provides the bank with a much greater degree of comfort. This, incidentally, is one reason why some companies which fall within the small company criteria (that is, with a turnover of less than £6.5m) nevertheless elect to have their accounts audited.
On the first point, the audit firm can add value for the client in a range of ways, not least in the way the audit firm may be able to help resolve the typical "chicken or egg" dilemma that companies get into with respect to the "going concern" provisions in accounting standards.
This is a hugely important provision since, by law, directors are not supposed to continue trading when a company is technically insolvent.
The problem, however, is that it is often not 100% clear when the line that separates a solvent from an insolvent entity has been crossed. In many instances this will depend crucially on the position of funders and whether the bank is prepared to continue to support the company.
This is where the audit firm can play a crucial role. "What we come across, time after time, are instances when the company would be a going concern if the bank took the decision to continue its funding arrangements. So we are more or less in the position of being suspended over the going-concern opinion waiting for some indication that the bank, which is probably waiting on our opinion, is prepared to continue funding. That is a perfect illustration of the chicken or egg problem," Young says.
When the bank knows and respects the audit firm this can often be positively resolved and, from the company's standpoint, that matters hugely. However, there is little by way of a formal procedure for resolving any stand-off between the bank and the auditor in this kind of situation and it can slow down the whole audit.
"We have a great deal of experience at speaking to banks and at explaining to the banks where we are coming from with the going-concern opinion. That definitely helps the client," Young says.
Most bank facilities will have covenants (conditions to the funding) that are tested against the audited accounts. Good management accounts will help companies to avoid breaching those covenants through oversight or neglect.
"Where we get involved in the value-added work is in providing a sense check, as it were, for our clients," Young says. "We help them to drill in to the numbers and see the trends. We also bring in pure accounting skills such as margin analysis, and looking to the integrity of the accounts, checking that nothing has been misposted, and that all the sales for the quarter that should have been included are."
Most entrepreneurs have a really good grasp of the metrics that are key to their particular operations in the early years.
However, as the business grows, getting the right management accounting information out of the system gets progressively harder to do – unless the business has the right tools.
John Black, partner and head of audit at Anderson Anderson & Brown points out that company business models tend to be very varied and complex, far more so than, say, a decade back. So the challenge for a SME's accountancy adviser is to make sure that the whole spectrum of management and accounting information is covered.
"You want to be able to drill down, as the head of a SME. You probably know your sales and operating profits, but you want to be able to see what a particular customer has been provided with by your company over the year.
"You have to be able to analyse your sales by customer and product. Moreover, knowing your break-even points on any of the lines that you are selling is critical," Black adds.
There will be an interaction, for example, between volume and pricing for most businesses, many of which will give discounts to customers based on the volumes bought.
However, what is essential, Black says, is knowing what your break-even points are so that you do not "give away" vital margins. "Most business owners are very aware of their break-even points," he says.
Black points out that, particularly in these difficult times, a business's ability to generate cash from sales is crucial. The firm's auditors will look first at that when they are considering the "going-concern" provisions as part of the annual audit. "For my part, I always start at the cash flow when analysing a company's accounts. If that is not a positive number, then the business has problems," he notes.
Anderson Anderson & Brown is in the final throes of developing a web-based financial modelling system for use by SMEs. "This is a financial projections model which gives smaller businesses access to a financial modelling solutions system through the Cloud," Black says.
"It is intended to be an alternative to spread sheets, which suffer from the fact that they can be very idiosyncratic to particular individuals and hugely difficult to check if that individual is no longer available.
"The aim is to help business people model their business and do forward projections, looking at critical areas such as profitability and cash generation. We felt that there was a gap in the market for a system that would enable businesses to take a variety of in-depth views of their data," Black says. The firm plans to roll the system out later this year.
Greg Callan, a director at accountants Macfarlane Gray, says that, for small businesses below the compulsory audit threshold, by far the most important service they can get from accountancy firms is outsourced support.
This can be in the form of the client bringing all their paperwork for payroll or accounts to the firm's offices, if for example, they are working out of a start-up unit without proper offices, or it can involve a member of staff going to the client's site at the end of the month and helping them to close the books – or doing it for them!
"This allows the business manager to concentrate on what they do best and can save them many hours of administrative hassle," Callan says.
